A Fair Distribution of Oil and Gas Revenues for Newfoundland and Labrador: A Feasibility Study
by
© Dongjun Lee
A thesis submitted to the School of Graduate Studies in partial fulfillment of the requirements for the degree of
Master of Arts in Environmental Policy
School of Science and the Environment /School of Graduate Studies /Environmental Policy Institute
Memorial University of Newfoundland – Grenfell Campus September 2020
Corner Brook Newfoundland and Labrador
ii Abstract
This study aimed to investigate a way to a sustainable future of Newfoundland and Labrador through the introduction of a Sovereign Wealth Fund (SWF) using the province’s oil and gas resources. The theoretical frameworks for this study are the capital approach of weak sustainability, environmental justice, and resource curse. With these frameworks, a comparative case study analysis has been adopted to investigate cases of two jurisdictions that are already successfully operating SWFs funded by oil and gas revenue to build more sustainable societies by sustaining their economic, environmental, human, and social capitals. Based on the case studies, this feasibility study examined the following questions:
1) What impacts did the Norwegian SWF have on the sustainability of Norway? 2) What impacts did the Alaskan SWF have on the sustainability of Alaska? 3) How does the oil and gas industry affect Newfoundland and Labrador's sustainability and what improvements should be made? 4) Will Newfoundland and Labrador be able to ensure sustainability with their oil and gas revenue? The study concludes that introducing a SWF could help to ensure the sustainability of Newfoundland and Labrador, with several supporting policies, such as diversified funding sources, building a framework that can benefit local people, and achieving social consensus.
iii General Summary
This study aimed to investigate a way to a sustainable future of Newfoundland and Labrador through the introduction of a Sovereign Wealth Fund (SWF) that is collected from non-renewable resources revenues and is managed by the provincial government. The cases of Norway and Alaska that are already successfully operating SWFs are investigated and are compared using SWOT analyses to draw lessons for Newfoundland and Labrador's sustainability. The study uses as theoretical frameworks the concepts of sustainability and environmental justice. It concludes that introducing a SWF could help ensure the sustainable development of Newfoundland and Labrador, economically, socially and environmentally. Several supporting policies are recommended, such as diversified funding sources for the proposed SWF, building a framework that can effectively benefit local people from using their oil and gas resources, and achieving social consensus.
iv Acknowledgment
During my graduate studies, I went through many issues in my personal life. I am grateful that there were people around me who helped me. I am grateful that there were always people around me during that time.
I would like to thank my supervisor Dr. Gabriela Sabau and Dr. Roza Tchoukaleyska for guidance and support to finish my degree. I would not be able to finish my thesis without their help. I also would like to thank my friends in my country who always give supports and cheer me up; Dr. Youah Lee at Korea Institute of Energy Research, Dr. Jihyo Kim at Korea energy Economics Institute, Dr. Sul-ki Lee and Minji Kim at Korea Institute for Industrial Economics & Trade. Finally, I am grateful to my family for all the supports in my life.
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Table of Contents
1. Introduction ... 1
1.1 Introduction ... 1
1.2 Research Background: Oil and Gas Industry in Newfoundland and Labrador ... 4
1.3 Research Objectives and Questions ... 9
1.4 Overview of This Study ... 12
2. Literature Review ... 14
2.1 Introduction ... 14
2.2 Wealth and Sustainability ... 16
2.3 Non-renewable Natural Resources and Sustainable Development ... 24
1) The “Resource Curse” ... 27
2) Global Environmental Justice ... 31
2.4. Sovereign Wealth Funds ... 35
2.5 Conclusion ... 39
3. Research Methods ... 41
3.1 Introduction ... 41
3.2 Research Design ... 42
4. Case Study 1: Norway ... 48
4.1 Introduction ... 48
4.2 Norway’s SWF: The Government Pension Fund ... 49
4.3 The Sustainability of Norway and the Oil and Gas Industry ... 53
4.4 SWOT Analysis ... 68
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4.5 Conclusion ... 73
5. Case Study 2: Alaska ... 75
5.1 Introduction ... 75
5.2. Alaska’s SWF: The Alaska Permanent Fund ... 76
5.3 The Sustainability of Alaska’s Oil and Gas industry ... 79
5.4 SWOT Analysis ... 93
5.5 Conclusion ... 98
5.6 Summary of the Norwegian Model and the Alaskan Model ... 99
6. Addressing Sustainability Challenges in Newfoundland and Labrador and Its Oil and Gas Industry ... 103
6.1 Introduction ... 103
6.2 Oil and Gas Industry and the Capitals in Newfoundland and Labrador ... 104
6.3. Discussion on the Potential SWF for Newfoundland and Labrador ... 127
6.4 Conclusion ... 140
7. Conclusion ... 143
7.1 Summary and Conclusion ... 143
7.2 Policy Recommendations ... 151
7.3 Recommendations for Future Research ... 154
References ... 156
vii List of Tables
Table 1. CO2 Emissions to Air in Norway 1990 - 2018 ... 61
Table 2. Number of Employees in Oil and Gas Industry in Norway 1990 - 2018 ... 63
Table 3. The SWOT Matrix for the Case Study of Norway ... 73
Table 4. The APF Balances and Dividends ... 81
Table 5. Greenhouse Gas Emissions to Air in Alaska 1990 - 2015 ... 88
Table 6. Alaska Oil and Gas Industry Employment ... 91
Table 7. The SWOT Matrix for the Case study of Alaska ... 98
Table 8. Summary of the SWOT Analysis ... 102
Table 9. The Oil and Gas Industry's Contribution to the GDP in Newfoundland and Labrador ... 106
Table 10. Oil and Gas Royalties and the Newfoundland and Labrador government’s revenue ... 107
Table 11. Net Debt of the Provincial Government of Newfoundland and Labrador ... 107
Table 12. Benefits and Payment of the Provincial Government of Newfoundland and Labrador under the Atlantic Accord Amended in 2019 ... 108
Table 13. The METRRs on Conventional Oil and Gas Investments in Selected Jurisdictions as of 2018 ... 112
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Table 14. Greenhouse Gas Emissions to Air in Newfoundland and Labrador 1998 - 2017 ... 118 Table 15. Employment Impact of the Oil and Gas Industry in Newfoundland and Labrador ... 121
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List of Figures
Figure 1. Location of Major Oil Fields, Offshore Newfoundland, Eastern Canada. .. 7 Figure 2. Export value of Norwegian Petroleum, 1971-2017 ... 54 Figure 3. Total Market Value of the Government Pension Fund Global ... 55 Figure 4. Historical and Expected Oil and Gas Production in Norway, 1970-2023 . 57 Figure 5. Crude Oil Production in Alaska ... 84 Figure 6. Alaska Crude Oil Proven Reserve... 85 Figure 7. Crude Oil Production in Newfoundland and Labrador ... 113
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List of Symbols and Abbreviations
ANCSA Alaska Native Claims Settlement Act of 1971 APF Alaska Permanent Fund
APFC Alaska Permanent Fund Corporation BOE Barrels of Oil Equivalent
BBbls Billion barrels
C-NLOPB Canada-Newfoundland and Labrador Offshore Petroleum Board CERI Canadian Energy Research Institute
EA Environmental Assessment
FISH-NL Federation of Independent Sea Harvesters of Newfoundland and Labrador FFAW Fish, Food and Allied Workers Union
GPFG Government Pension Fund Global GHG Greenhouse Gas Emissions GDP Gross Domestic Product IWI Inclusive Wealth Index
METRR Marginal Effective Tax and Royalty Rate MMbbls Million Barrels
NLPPF Newfoundland and Labrador in the Pooled Pension Fund NOK Norwegian Krone
OECD Organisation for Economic Co-operation and Development PFD Permanent Fund Dividend
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SCC Social Cost of Carbon SWF Sovereign Wealth Fund
SDFI State’s Direct Financial Interest
SWOT Strengths, Weaknesses, Opportunities, and Threats TAPS Trans Alaska Pipeline System
UNEP United Nations Environmental Programme
UNCLOS United Nations Conventions on the Law of the Sea
UNU-IHDP United Nations University's International Human Dimensions Programme on Global Environmental Change
US United States of America USD United States Dollar
EIA United States of Energy Information Administration WCED World Commission on Environment and Development
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1. Introduction
1.1 Introduction
The oil and gas industry is an important component of Newfoundland and Labrador’s economy. The oil and gas industry yielded about 21% of the province's industrial gross output in 2016, and this contribution is a larger contribution then even manufacturing industry in Newfoundland and Labrador (Statistics Canada, 2020). The dependency, however, has been a double-edged sword for the economy of Newfoundland and Labrador.
When oil price was high, Newfoundland and Labrador has experienced economic growth with more employment and fiscal benefits; however, the economic boom brought by oil can rapidly come to an end (Palladini, 2015; Seth Kwei, 2019). On the other hand, when oil price is low, just as the current low oil price since mid-2010s, Newfoundland and Labrador experienced huge losses of welfare and economic downturn (Carbone &
McKenzie, 2016). In 2008, the contribution to GDP of the oil and gas industry reached its highest level with $11.7 billion, however, it decreased to $4.7 billion in 2017 with the slumping oil price that began late in 2014 (Government of Newfoundland and Labrador, 2009, 2019c). Newfoundland and Labrador is now one of Canada's most economically challenged provinces. The province is experiencing the greatest decrease of the number of young labour force since 2012, and the unemployment rate was 13.8% in 2018 which was much higher than the national unemployment rate of 5.8% (Government of Canada, 2020).
The provincial government’s debt hit the record high with $15.4 billion in 2019 (Auditor General of Newfoundland and Labrador, 2019).
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The future of the oil and gas industry in Newfoundland and Labrador seems to be not great either. The Carbon Tracker, an independent financial think tank, asserted that there will be low demand for oil and gas resources from Newfoundland and Labrador’s offshore because of the increasing risk of climate change and its higher production cost on Newfoundland and Labrador’s offshore than its production cost on other offshores (Atlantic Business, 2019). Also, the oil price trend is not helpful either. Recently, the United States Energy Information Administration (EIA) has insisted that the oil price will not be recovered in a short-term as they predict that the annual average price of Brent crude oil, which is a benchmark for Newfoundland and Labrador oil, will be $34.14/barrel in 2020 and
$47.81/barrel in 2021 which is significantly lower than its price of $64.37 in 2019 (U.S.
Energy Information Administration, 2020b). Without any significant changes in policies for their oil and gas resources, the future of Newfoundland and Labrador is seems to be downfall.
Meanwhile, in 2018, the provincial government of Newfoundland and Labrador unveiled a plan named “the Way Forward” that included plans to drill over 100 new exploration wells and double its oil production by 2030 (Oil and Gas Industry Development Council, 2018). Therefore, aside from the plan to increase oil and gas production, Newfoundland and Labrador needs to figure out how to make the benefits from the oil and gas industry sustainable, even when there is a downturn in the global oil market or when its oil and gas resources are no longer available.
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From this awareness, this study aims to search for a way to a sustainable future of Newfoundland and Labrador using their oil and gas resources, with an assumption that the oil price will stabilize again after the Covid-19 outbreak is over and economies start working again. In other words, how benefits from oil and gas resources should be distributed between the oil and gas companies and the province of Newfoundland and Labrador to sustain the benefits of oil and gas resources and keep the benefits at a sustainable level is a major concern of this study. The ideal way of benefit distribution from oil and gas resources in this study is a “fair distribution” which is considered as a condition for sustainability (Alshuwaikhat & Mohammed, 2017; Van de Kerk & Manuel, 2008).
There are two aspects of fair distribution, which are inter-generational fair distribution and intra-generational fair distribution (Lamorgese, 2014; Warhurst Alyson, 2002). Inter- generational fair distribution refers to a fair distribution between succeeding generations (Warhurst Alyson, 2002). Intra-generational fair distribution refers to a fair distribution of resources within the current generation, such as between oil companies and local people (Elliott, 2005; Lamorgese, 2014). The fairness does not only mean economic fairness, but it includes social and environmental fairness also.
To distribute the benefits of resources fairly, a fund-based approach is frequently used in non-renewable resource sectors (Atkinson & Pearce, 1993; Hite, 2015). Under the fund approach, the government accumulates a significant amount of financial assets through oil production, which can be used and invested to satisfy the needs of the current and the future
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generations. Fund-based approaches facilitate a fair distribution of benefits to the public from extractive industries that utilize non-renewable natural resources, as they involve dispersing cash benefits for specific purposes (Hite, 2015). When the government owns a fund with investment strategies for macroeconomic policy purposes, the fund is generally called a Sovereign Wealth Fund (SWF) (Alhashel, 2015; Das & Lu, 2009; Beck & Fidora, 2008). SWFs are usually sourced from commodity export revenues, and they aims to stabilize government and export revenues, accumulate savings for future generations, and manage foreign reserves (Alhashel, 2015).
1.2 Research Background: Oil and Gas Industry in Newfoundland and Labrador The first exploration oil well in Newfoundland and Labrador was drilled in 1966 on the east coast. The economic viability, however, was not enough to begin commercial production of oil because there were many other oil fields globally capable of cheaper and easier production (Fusco, 2007). The situation changed dramatically after the first global oil crisis in 1973. With the surge of oil prices in 1973, interest in the oil resources of Newfoundland and Labrador started to rise significantly (Fusco, 2007).
Canada commenced negotiations on the continental shelf boundary at the United Nations Convention on the Law of the Sea (UNCLOS) conference in July 1970 and established a 200-nautical-mile off shore fishery zone in 1977, which was agreed to in 1982 (Esearch, 2019; Miller, 2007). It confirmed Canada’s authority over the development of the oil and
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gas resources on the Grand Banks (Esearch, 2019), but without defining jurisdictional control of the provincial government of Newfoundland and Labrador. The province of Newfoundland and Labrador has tried to claim jurisdictional control over its territorial sea and continental shelf (Fitzgerald, 1991). The province of Newfoundland and Labrador outlined an approach to develop their offshore resources in a government White Paper in 1977, which was to include:
1) A system of exploration and development permits for the lands claimed by Newfoundland and Labrador which ensures that work is actually done by permit holders; 2) Development and production of the resource in a reasonable time-frame consistent with other objectives (rather than leaving the resource unexplored and underdeveloped); 3) Maximization of the economic rents to be earned from the resource for the public sector; 4) Control of the rate of development to ensure maximized benefits and minimum disruptive impacts; 5) Environmental protection, with particular concern to protect the fishery; 6) Participation and involvement of residents of the province in planning offshore development. (Voyer, 1983, p.38).
On October 24, 1977, the province of Newfoundland and Labrador enacted offshore petroleum regulations that includes the following provisions:
1) preference for Newfoundland labor, goods, and services, 2) compulsory training, research, and development programs in the province, 3) the landing in the province of any oil and gas produced offshore, 4) minimum expenditures within the province,
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5) preference for local refining, processing, and consumption of oil and gas, and 6) provincial control over the rate of development. (Fitzgerald, 1991, p.6)
In 1979, the first major oil field in the Newfoundland and Labrador offshore was discovered at Hibernia on the Grand Banks off Newfoundland and Labrador. Both the provincial government of Newfoundland and Labrador and the federal government of Canada recognized the oil field as an important part of its energy strategy (Fusco, 2007). After years of negotiation between the federal government and the provincial government, they established a joint management system called the “Atlantic Accord” for Newfoundland and Labrador’s offshore, recognizing the priority of the province, and created the Canada- Newfoundland and Labrador Offshore Petroleum Board (C-NLOPB) to manage the offshore on behalf of both governments in 1985 (Fusco, 2007). The Atlantic Accord in 1985 aimed “to provide resource revenues to Newfoundland and Labrador as well as Canada, the attainment of national self-sufficiency and security of supply, and a stable and fair offshore management regime to the oil and gas industry” (Government of Newfoundland and Labrador, 1985, p. 1).
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Figure 1. Location of Major Oil Fields, Offshore Newfoundland, Eastern Canada.
Reprinted from “Reservoir connectivity analysis of a complex combination trap: Terra Nova Field, Jeanne d'Arc Basin, Newfoundland, Canada”, by Richards, F. W., Vrolijk, P.
J., Gordon, J. D., Miller, B. R. 2010, Geological Society Special Publication, 347, p.334
After the discovery of the Hibernia oil field, the Hebron oil field was discovered in 1980, then the Terra Nova and White Rose oil fields were discovered in 1984. The production of crude oil from the Hibernia oil field, however, was not started until 1997 because of the declined oil price, a prolonged development process, engineering problems, and the increasing price tag of the project due to those delays (Fusco, 2007). After a long-awaited
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process of development, Hibernia crude oil production started in 1997, and the oil and gas industry has become a more important basic industry than the fishing industry that was declining due to resource depletion (Coulombe, 2012). After the first crude oil production, Terra Nova crude oil production began in 2002, and White Rose oil production began in 2005 (Bott, 2004).
According to the Oil and Gas Industry Development Council (2018), Newfoundland and Labrador’s offshore has 2.2 Billion Barrels (BBbls) of discovered oil reserves left and 12.6 trillion cubic feet of natural gas discovered which needs to be developed. It is also estimated that there is 37.5 BBbls of oil and 133.6 trillion cubic feet of natural gas undiscovered in the West Orphan and Flemish Pass regions (Oil and Gas Industry Development Council, 2018). So far, the total amount of oil already produced in the Newfoundland and Labrador’s offshore is about 1.7 BBbls. Based on the “Way Forward” plan, the province of Newfoundland and Labrador plans to drill over 100 new exploration wells, and increase the daily production to over 650,000 barrels of oil equivalent per day (boe/d) by 2030. That is more than twice the current daily production. Other than these plans, the “Way Forward”
plan includes long-term plans of starting commercial natural gas production, growing the supply and service industry, and creating a world-class energy cluster (Oil and Gas Industry Development Council, 2018).
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Despite such positive forecasts, the oil and gas industry in Newfoundland and Labrador is undergoing hard times with the falling crude oil price started in late 2014. The price of Brent crude oil, which is a benchmark for Newfoundland and Labrador oil, was at US$105.79 in July 2014, however, it dropped to US$ 59.29/barrel in December 2014 (U.S.
Energy Information Administration, 2020b). Since then, the average annual crude oil price was US$48.66/barrel in 2015, US$43.29/barrel in 2016, US$50.80/barrel in 2017, US$65.23/barrel in 2018, and US$57.00/barrel in 2019 (U.S. Energy Information Administration, 2020b). The situation got much worse in 2020. As tensions between Russia and Saudi Arabia are escalated and global oil demands are significantly reduced mainly due to the COVID-19 pandemic, the monthly oil price in April 2020 dropped to US$16.55 and daily spot oil price once fell as low as minus $36.98/barrel (U.S. Energy Information Administration, 2020b). As oil prices fell, the oil industry in Newfoundland and Labrador, where production costs were higher than in other oil-producing regions, has been significantly impacted. The planned expansion process of the oil fields in Newfoundland and Labrador, such as the drilling program in the Hibernia oil field and the development of the West White Rose oil fields, has been suspended or deferred (Graney, 2020).
1.3 Research Objectives and Questions
This study aims to investigate a way for Newfoundland and Labrador to utilize its oil and gas revenues to secure the sustainability of the province of Newfoundland and Labrador, as announced in the “Way Forward” plan, which planned to increase oil and gas production.
This study assumes that the current pandemic will end and the oil price will rise again, but
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Newfoundland and Labrador could suffer if there are no political changes to its management of oil and gas resources, as global crises like the current situation can come again at any time. As aforementioned, the current management of oil and gas resources is not sustainable, so to convert them into sustainable benefit streams, which include environmental and social benefits as well as economic benefits, it is necessary to create a sizable fund and transfer the oil and gas revenues to the fund. There are two cases that have successfully done this, which are found in Norway and Alaska.
Norway and Alaska are both considered as good examples of jurisdictions that have created and managed SWFs successfully with their rich oil and gas endowments. Norway has the world’s largest SWF which was about 1,148 billion USD in 2019 (Norges Bank Investment Management, 2019a), and Alaska has the largest SWF amongst any territorial entity within a country, which was about 66 billion USD in 2019 (Center for the Governance of Change, 2020). Although there is a difference between Norway and NL, as Norway is a country and NL is a province in Canada, the considerations for a provincial fiscal policy are not much different from those for a national fiscal policy, as they are mainly a matter of economic variables, for instance, the size of the economy, the unemployment rate, and the debt capacity (Barber, 1968). The characteristics of different SWFs are determined by their objectives, such as stabilizing the economy, saving for a pension, or long-term development of the domestic economy (International Monetary Fund, 2008), and they are already widely and internationally adopted in many countries and provinces (states) regardless of the size of the economy (Eldredge, 2016).
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While Norway’s Alaska’s present good examples of SWFs, their primary way of spending the fund is different. While Norway’s SWF’s focus is to save the fund and finance future liabilities, Alaska’s SWF has a unique fund dividend system which provides a basic income for their residents. Alaska is the one US state that has a significantly lower poverty rate of 10.2% than the national average of 14.6%, thanks to the SWF funded by oil and gas revenue (Welfareinfo, 2017). Therefore, the SWFs of Norway and Alaska will be discussed as benchmarks for oil wealth distribution and investment, using oil and gas revenues (Murphy
& Clemens, 2013; Olawuyi & Onifade, 2018; Truman, 2009). Here, the distribution and investment of oil wealth means a stock of assets that includes economic, environmental, human, and social capitals to build sustainable society. What NL needs is to get the continued benefits from their oil and gas resources to sustain the development of the province as well as their environmental, human, and social capitals, not just gaining temporary economic benefits the way they have done so far. Thus, this study examines whether lessons from SWF frameworks can be applied to NL, based on the case studies of Norway and Alaska, to investigate a way for NL to utilize oil and gas income to secure the province’s sustainability. To achieve this research goal, the study aims to address four objectives and research questions:
1) The Norwegian SWF and the sustainability of Norway: What impacts did the Norwegian SWF have on the sustainability of Norway?
2) The Alaskan SWF and the sustainability of Alaska: What impacts did the Alaskan SWF have on the sustainability of Alaska?
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3) The oil and gas industry and the sustainability of Newfoundland and Labrador: How does the oil and gas industry affect NL’s sustainability and what improvements should be made?
4) The feasibility of the introduction of a SWF in NL and identify the challenges based on the case study results of Norway and Alaska: Will NL be able to ensure sustainability like Norway and Alaska with their oil and gas revenue?
Norway and Alaska are cases to demonstrate that SWF is an instrument that has the potential to maintain sustainability and achieve a fair distribution of wealth by using non- renewable resources. By examining the factors that led to the success of Norway and Alaska, this study intends to argue that it is feasible for NL to achieve sustainability through the introduction of a SWF using the oil and gas resources in the province, after the Covid-19 outbreak is over and economies start working again, with an assumption that the provincial government of NL has the politicalwill for a sustainable future for the province.
1.4 Overview of This Study
This study consists of seven chapters. This first chapter provides the background and objectives of this study, to explain the rationale of this research. Chapter 2 provides a literature review that covers concepts and theories which are conceptual frameworks for this study. The concepts and theories in this chapter explain what factors should be reviewed to investigate sustainability issues related to the fair distribution of oil and gas revenues. Chapter 3 provides a research methodology and outlines the research design.
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Chapter 4 and Chapter 5 provide the case studies of Norway and Alaska. These chapters investigate the background of how Norway and Alaska created their SWF frameworks; the impacts of the SWFs on the sustainability of their societies; and compare the results of the case studies to provide implications for NL. On the basis of these results, Chapter 6 investigates a way for NL to utilize its oil and gas revenue to secure their sustainability and discusses its feasibility and challenges. Lastly, Chapter 7 provides a summary and conclusion of this study, and outlines some policy recommendations aimed to ensure the sustainability of NL. It also discusses the limitations of the study and makes recommendations for further research.
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2. Literature Review
2.1 Introduction
The issue of distribution of wealth generated from natural resource extraction has received growing attention, especially when focused on non-renewable/exhaustible resource extraction. The wealth from non-renewable resource extraction has generated both positive and negative effects on the sustainability of a society that relies for its development on non- renewable resources. To discuss how to fairly distribute the wealth generated from natural resource extraction, the concepts related to those effects on sustainability need to be investigated.
The revenue from non-renewable resources exploitation needs to be managed carefully to assist in achieving the sustainability of a society. The natural resources are key inputs for sustainable development; however, the nature of non-renewable resources inevitably raises concerns on the issues of sustainability. The first reason is that natural resource abundance is not always considered a blessing which guarantees high economic growth due to the so- called “resource curse” (Sachs & Warner, 1997, 2001). The second reason is that the development using the revenue from non-renewable resources raises concerns on global environmental justice, which refers to justice in terms of cross-border distribution of environmental burdens and benefits because the cost of development can be imposed on the group who does not benefit from the development (Blake, 2011). The revenue from
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non-renewable resources should be managed for minimizing these impacts. A SWF is one type of financial instrument to manage the revenue from non-renewable resources towards sustainable outcomes, as it is largely motivated by the need for ensuring the stability and security of a nation (Sun et al., 2014). This study considers creating a SWF for the province of NL in Canada as a way to reduce the aforementioned problems of development using non-renewable resources, because a SWF can be used to convert oil and gas revenue into financial capital that can be invested for the public good.
This chapter will examine the concepts related to the distribution of oil and gas revenues, as they are presented in the existing literature. The literature examined in this section includes peer-reviewed papers, reports from think tank institutions, international organizations, and theses. Those literatures published cover publications mostly from 1990 to 2019 with several exceptions of those published in 1980s and 1970s. Several themes can be identified in the literature, which are: 1) the difference between the concepts of wealth and revenue, and how they can be used to achieve sustainability of a society; 2) how sustainability in a society can be accomplished with non-renewable resource revenue; 3) what a SWF is and why it is important when it comes to the fair distribution of oil and gas revenue.
16 2.2 Wealth and Sustainability
The emergence of the concept of wealth is related to the concerns about sustainability and the struggle to overcome the limitations of traditional macroeconomic variables, such as gross domestic product (GDP). The ultimate goal of this study is to figure out how to make the NL province benefit from its oil revenue not only for the future generations but also for the current generation by attaining sustainable socio-economic outcomes using their oil and gas resources. This is in line with the classical definition of sustainable development from the World Commission on Environment and Development (WCED) report of 1987 that states: “Humanity has the ability to make development sustainable to ensure that it meets the needs of the present without compromising the ability of future generations to meet their own needs” (WCED, 1987, p. 16). Considering this concept of sustainable development, sustainability in this study can be defined as preserving the level of well- being over time with the capacity to sustain the well-being for the future generations as well as for the current generation at the same level (Vivien, 2018). GDP cannot measure sustainability since it measures only current income and production of goods and services without considering the assets for long term development (The World Bank, 2018). For example, GDP can be boosted by over-exploiting natural resources, however, this process lowers the opportunity of future production capacity. Sustainability is about sustaining and enhancing the opportunities available to both current and future people in society, and the opportunities depend on the accumulation of wealth (Weitzman, 2016) not only on GDP growth. Wealth in this study is considered a stock of assets including all tangible and intangible assets an economy has minus its liabilities, while income is considered a flow
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which measures the amount of money (or goods) that is obtained over a given interval of time and gets added to the stock of wealth. Therefore, the level of GDP cannot be equated with the level of well-being in a society, and the policy decisions based on only traditional economic indicators lead to poor decisions without full information. To address the well- being of society, inspecting the level of various capital stocks used jointly to produce well- being over time is considered a coherent approach (Uwasu & Yabar, 2011).
Early studies on sustainable development, such as Solow (1974) and Hartwick (1977), theoretically presented that economic growth can be sustained when earlier generations draw down the finite pool of non-renewable natural resources optimally and they add optimally to the stock of reproducible capital. The reproducible capital refers to man-made capital such as machines, which is considered as compensation for non-renewable resources used (Hediger, 1997). According to Solow (1974), the proportional rate of change of the marginal productivity of the resource should always equal the level of the marginal productivity of reproducible capital to be on the optimal path of development. The approach to measuring the sustainability of society by estimating these capitals is called the "Capital approach". The significance of the capital approach is that the stock of capitals is considered to give the capacity to grow the stream of goods and services in the society (Ekins et al., 2003)., and the stock of capitals should be non-decreasing. Atkinson and Pearce (1993) provided a crystallized explanation of the capital approach to sustainability in the early stage. In the capital approach, the amount of goods and services produced in society is linked to the level of various types of capital existent in the society which is used for the
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production process. The amount of these capitals is used to estimate the level of wealth.
Atkinson and Pearce (1993) assumed that there are 2 types of capital, which are man-made capital and natural capital, and they can be substituted each by the other. Atkinson and Pearce (1993) assert that an economy is sustainable if the economy saves more than the combined depreciation of the capitals. This is referred to as a weak sustainability rule.
According to the study, the value of saving in a society, which is the potential source for future investment, must be larger than the summation of the value of depreciation of man- made capital and the value of depreciation of natural capital to maintain the weak sustainability of a society. On the strong sustainability rule, there is a critical quantity of natural capital (resources) that must be maintained intact if the well-bring of the future generation is not to decline, which implies the non-substitution of man-made capital for natural capital (Hamilton, 1995).
Based on these works, many studies introduce the concept of wealth as an indicator of the sustainability of the national economy. A theoretical concept of wealth relating to economic theory is the present value of future consumption which is dependent on amount of capitals in a society (The World Bank, 2006, 2011, 2018). Hence, the estimates of wealth can provide a useful indicator of the sustainability of society as the amount of wealth is founded on the amount of capitals that future generations can consume (The World Bank, 2018). If the wealth was distributed unfairly, the sustainability of the economy cannot be achieved.
Unfair wealth means wealth that is immediately gained owing to consuming the private or public wealth already saved up by others (Savin & Rovenskaya, 2011). Since wealth is
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about the sustainable growth of a society, unfair wealth can decline the sustainability and living conditions of the public. Chang (2012) mentioned that social relationships regarding resource allocation among people are also important and there will be no efficiency without a fair distribution of wealth. Therefore, there should be a policy instrument to make an unfair wealth distribution fair in order to sustain well-being in a society.
The significant linkages between wealth and sustainability have noticed by a series of papers since the 1990s, such as the World Bank (1997), Hamilton and Clemens (1999), and Dasgupta and Mäler (2000). The World Bank (1997) report explores indicators of environmentally sustainable development that include the links between environmental quality and economic growth and between the consumption of resources and the quality of the resource stock. The focal point of this report is that “economic growth that causes rapid resource depletion, degradation, major health problems and productivity impacts on the public is neither sustainable nor desirable” (The World Bank, 1997, p. 11). This is worthwhile to mention because it notes that the impact of economic growth on human as well as resource depletion and degradation has an important impact on creating wealth.
Hamilton and Clemens (1999), motivated by the World Bank (1997) report, developed the theory of “genuine savings” which describes the relationship between the wealth account and resource depletion, environmental degradation, and the value of investments in human capital (Hamilton, 1994). They explore the connections between changes in wealth and changes in intergenerational well-being. The rationale of considering “genuine savings” as an indicator for national wealth is “the incomplete treatment of resource issues” within the
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system of national accounts (Hamilton & Bolt, 2007. p. 292). For example, commercial natural capital stocks are measured in the national accounts, but there is no adjustment to reflect the consumption of capital when these stocks are decrease as they are exploited (Hamilton & Bolt, 2007). When the depletion of natural capital is ignored within national accounts, it brings unsustainability of the country, as the depletion may be harmful for future generations. The measurement of genuine savings takes into account the depletion of natural assets that is calculated as a rental rate on commercial resource production plus global damages from CO2 emissions to valuate wealth. This makes the sustainability of natural capital an important factor when measuring wealth using the concept of genuine savings. This is important since the over-exploitation of natural resources without considering the sustainability leads to declines in economic growth and social welfare (Lampert, 2019). Based on this deliberation, the World Bank has published national
“genuine savings” estimates in their reports, annually. The genuine savings measurement encompasses physical, human and natural capital based on weak sustainability, which is premised on substitutability between physical, natural and human capital (Pillarisetti, 2005).
Therefore, one of the policy implications of the theory of genuine savings is that negative rates of genuine savings lead to declining well-being; however, policymakers can make achievable interventions to increase sustainability based on this relationship (Hamilton &
Clemens, 1999). Hamilton et al. (2006) extended the findings of Hamilton and Clemens (1999) to analyze the role of the management of wealth through saving and investments.
Their emphasis on saving is a core aspect of development as there is no way for countries to escape poverty without making a surplus for investment. Arrow et al. (2010) extended the theory of genuine savings to provide a consistent framework that incorporates
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population growth, technological change, human capital, and environmental quality. Also, they incorporated the effects of expected capital gains in natural resource stocks and health as a kind of capital within their model.
In June 2012, the United Nations University's International Human Dimensions Programme on Global Environmental Change (UNU-IHDP) and the United Nations Environmental Programme (UNEP), a biennial series of reports on the sustainability and wealth of countries at the Earth Summit 2012 (Rio+20). UNU-IHDP and UNEP (2012) discussed the construction of the wealth accounts, proposing the concept of the Inclusive Wealth Index (IWI). This index provides quantitative information on human well-being and measures of sustainability on a long-term perspective. There are a few differences between “genuine savings” and IWI in terms of how to calculate the level of capitals and sustainability, but the IWI also offers a capital approach to sustainability considering natural capital, produced capital, human capital, and social capital and measures the social value of capital assets of nations. The value of natural capital is measured based on everything in nature capable of providing human beings with well-being, such as fossil fuels, forest resources, agricultural land, and fisheries (UNU-IHDP and UNEP, 2014;
UNU-IHDP & UNEP, 2012). The value of produced capital is measured based on equipment, roads, buildings, machinery, and others which are usually accumulated from the investment of national income (UNU-IHDP & UNEP, 2014; UNU-IHDP & UNEP, 2012). The value of human capital is measured based on the knowledge, skills, competencies, and attributes embodied in individuals, such as population size, life
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expectancy, mortality probability, employment, educational attainment, employment compensation, and labor force (UNU-IHDP and UNEP, 2014; UNU-IHDP & UNEP, 2012).
The value of social capital is measured based on the social relationships and institutions that facilitate action, in terms of the importance of obligations and expectations, information channels (UNU-IHDP and UNEP, 2014; UNU-IHDP & UNEP, 2012). And each capital category embeds intangible asset, which is hard to be quantified, in order to capture as much wealth as possible within the categories. IWI is considered as a stand-out indicator of sustainability and well-being as it has a theoretical foundation from economics and can give policy implications to decide where to invest to increase the level of sustainability in a society (Ikeda et al., 2017; Roman & Thiry, 2016). The UNU-IHDP and UNEP (2012) reports, which is the first series of reports that utilize IWI to address national sustainability, have specified several lessons of the IWI on the policy making considering the sustainability of the nations. Firstly, The IWI assumes that capitals can be substitutes for each other. Therefore, under the inclusive wealth framework, the reason why natural capital is preserved is not only because natural capital needs to be preserved, but also because the natural capital can be converted to other forms of capital to achieve sustainable development. The possible substitution between capitals apply to other capitals, too. This assumption is criticized by other studies due to the limited substitutability between capitals, especially because natural capital cannot or should not be substituted (Bailey, 2017; Cohen et al., 2018; Ekins et al., 2003). Second, as a part of measuring natural capital, UNU-IHDP and UNEP (2012) bring up the interconnected externalities of global environmental issues.
The reports especially point out climate change as an important transboundary threat on inclusive wealth while there are other issues such as biodiversity loss and loss of fisheries.
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The third is the shadow price of capitals. The shadow price reflects the degree of substitution between capitals assets, intergeneration benefits by the capitals, and the scarcities of the capitals (UNU-IHDP & UNEP, 2012). Theoretically, a shadow price should be properly reflected in the market price of the capital. However, on the practice of sustainability study, the shadow price of capitals is problematic as those are usually not observable on the market, especially for natural capital, human capital, and social capital, in that order (UNU-IHDP & UNEP, 2012).
Although there are some theoretical differences between the sustainability accounts proposed, sustainability of nations is about having many types of capital and how they might be substituted for one another over time to meet the needs of the current generations and of the future generations (Hamilton & Hartwick, 2014). Using these capitals more efficiently and increasing their productivity are crucial for sustainable economic growth (Sustainable Prosperity, 2014). The capital approach to sustainability has a strength that provides a constructive guide to policymakers to manage national wealth (Atkinson &
Atkinson, 2008). Produced capital (human-made capital) is capital that can be used
“repeatedly or continuously in production processes for more than one year, such as machinery, buildings, roads, harbours and airports and stocks of raw materials, semi- finished and finished goods held for future sale and intangible types of goods” (Saunders et al., 2010, p.6). Natural capital refers to “the stock of natural ecosystems that yields a flow of valuable ecosystem goods or services which do not have substitutes from produced capital” (Maack & Davidsdottir, 2015). Human capital is regarded as “the stock of
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economically productive human capabilities, such as knowledge, skills, competencies, and attributes embodied in individuals”(Saunders et al., 2010, p.7). Social capital consists of “a stock of trust, mutual understanding, shared values and socially held knowledge which impact on society’s productivity” (Maack & Davidsdottir, 2015), such as political, legal, and commercial institutions, sense of community, participation, and interaction in local and external networks. The Organisation for Economic Co-operation and Development (OECD) defines social capital as “the social norms, shared values and institutional arrangements that foster co-operation among population groups” (OECD, 2020, p. 234).
The capital approach incorporates the four capitals that are relevant to sustainability (OECD, 2004). And aside from these capitals, some scholars include the financial capital in their approach for sustainability that is a liquid asset which allows interchange between capitals and can be invested in production activities, saved in the form of the national currency that is expected to rise in value, or in ownership shares (Goodwin, 2003; Maack
& Davidsdottir, 2015). It is also used to own or control the four capitals above mentioned (Goodwin, 2003).
2.3 Non-renewable Natural Resources and Sustainable Development
According to the aforementioned discussion on sustainability, natural capital is a critical input for sustainable development. The inevitably finite nature of non-renewables, however, has raised concerns on the issues of sustainability, such as inter-generational access to these
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resources, the environmental impacts associated with their production and use, and the social impacts on local communities (Cowell et al., 2000). The publication of the Club of Rome’s report in the 1970s, "The Limits to Growth", increased these concerns, as the report showed that exponential population growth and exhaustible resource use would lead to decline in the quality of life in the world (Meadows et al., 1972).
However, some authors consider that there are still several ways to maintain weak sustainability with non-renewable natural resources with proper management of the resources, even though the non-renewable natural resources cannot be renewable in a predictable time span. Auty (2014) pointed out that sustainable development and harnessing of non-renewable resources are compatible if the potential environmental damage arising from the exploitation of non-renewable resources can be substituted with other natural resources. He asserted that a sufficient fraction of rent from non-renewable resource development must be invested to substitute for the damages. Therefore, the exploitation of non-renewable resources does not necessarily bring the non-sustainability of society. Rather, resource development can yield many benefits for sustaining weak sustainability. Söderholm and Svahn (2015) categorized the types of benefits from non- renewable natural resources into monetary benefits and non-monetary benefits. The monetary benefits include development and investment funds, equity sharing, and tax sharing with governments, and the non-monetary benefits include educational facilities, medical facilities, employment goals, local procurement, training of staff, and improved service access (Söderholm & Svahn, 2015). Sequeira and Sarkar (2017) categorized the
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types of benefits by the phase of resource development. In the short and medium run, communities can get benefits from local employment, opportunities for local suppliers, skills training, and road construction. In the long run or in the focus on sustainability, communities can get benefits from community development programs, the shared revenue stream from royalties, and livelihood activities, and these benefits are tied to investing companys’ profits.
However, aside from the finite nature of the non-renewable natural resources, there are more factors that can diminish the sustainability of society. The development of oil and gas brings booms and busts in an economy as a part of its history (Shields, 1998). Although there is a lack of consensus on its causes and consequences, the “resource curse”
phenomenon is a challenging issue for the countries exploiting oil and gas resources.
Moreover, the fundamental problem of non-renewable natural resource use for sustainability is that every stage in the life cycle of a non-renewable natural resource is associated with activities that are potentially harmful to the environment (Shields, 1998).
These potential harms are global in nature and thus bring concerns about global environmental justice. The following subsections explain these concepts.
1) The “Resource Curse”
There has been a belief that natural resources, such as oil and gas, are a blessing that lets countries base their development on these resources (Badeeb et al., 2017a). The belief
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collapses in some resource-rich countries as seen from case studies such as Amuzegar (1982), Gelb (1988) and Auty (1990). Amuzegar (1982) has found out that increased dependence on petroleum in oil-rich countries brings budgetary deficits, external debt, unemployment, and, most importantly, declined sources of livelihood and growth (Amuzegar, 1982). Gelb (1988) has found that oil exporting countries experienced a more serious deterioration during the boom period of 1971–1983, and the cost of using oil windfalls offset the gains from the oil windfalls. After that, a sizable literature showing that natural resource abundance can be a curse has emerged since the 1980s and has increased over time (Badeeb et al., 2017b). The "resources curse" refers to the paradox that countries with great natural resources, specifically exhaustible resources, tend to grow more slowly than resource-poor countries (Sachs & Warner, 1997, 2001). There are several different explanations of why a resource curse can happen in some countries. Explanations can be divided into two distinct but overlapping categories, which are, economic factors, such as the “Dutch disease” and price volatilities, and political factors, such as corruption and institutional quality (Badeeb et al., 2017c).
Corden and Neary (1982) and Corden (1984) made large contributions to developing a model of the “Dutch Disease” phenomenon named after the decline of Dutch manufacturing after the discovery of natural gas in the North Sea. The “Dutch Disease”
refers to the adverse effects on the Dutch manufacturing sector of the natural gas discoveries through the subsequent appreciation of the real exchange rate of the Dutch gulden (Corden, 1984) which had diminished the country’s net exports. “Dutch disease”
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occurs when natural resource booms increase incomes and the demand for goods, and these increases generate inflation and appreciation of the country’s currency real exchange rate (Badeeb et al., 2017c). The “Dutch Disease” is likely to happen when the countries fails to promote a competitive manufacturing sector and depend largely on resource revenues as the inflow of resource revenue can appreciate the country’s currency (Li, 2013).
Humphreys et al. (2007) pointed out another unique characteristic of resource revenue as a reason for the resource curse. The generation of natural resource wealth can occur independently of other economic processes that take place in a country (Humphreys et al., 2007). For example, it can take place without major positive contribution to other industrial sectors and the participation of a large portion of the domestic labor force when they are operated by multinational enterprises or joint enterprises (Humphreys et al., 2007). Also, resource wealth tends to be repatriated rather than reinvested in the domestic economy (Heinrich, 2011). In this case, there are limited chances to promote domestic industries related to resource extractions and benefits from the extraction are unlikely to be reinvested for the development of the domestic economy (Heinrich, 2011).
Also, resource extraction decisions can take place quite independently of other political processes, when a government can access natural resource wealth without any prior agreement of the citizens or institutions (Humphreys et al., 2007). These distinguishing features of natural resource wealth use can cause the “resource curse”. Therefore, both the government and the companies can and should develop a scheme to ensure more effective and fair development of oil resources (Humphreys et al., 2007).
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Bauer (2013) brings up the volatility issues of resource revenue. Over the short to medium term, the volatility of resource revenue leads to “wasteful spending, poor quality investments, unpredictable business environments, and ultimately slow growth of relevant sectors” (Bauer, 2013, p.1). Over the longer term, the finite nature of oil and gas revenues leads to “economic depression and difficulty in scaling up public investment efficiently”
(Bauer, 2013, p.1). Davis and Tilton (2005) point out that commodity price volatility causes fluctuations in government revenue and export income. Particularly, oil-exporting countries, such as Canada and Norway, can be negatively impacted by oil price volatility in terms of GDP and industrial production (Elder & Serletis, 2009; van Eyden et al., 2019;
Wang et al., 2013). Carbone and McKenzie (2016) also found large welfare losses in the oil-rich provinces in Canada, such as Newfoundland and Labrador, Alberta, and New Brunswick, due to the oil price shock since late 2014. The province of NL has been affected the most amongst the provinces in terms of economic welfare and there was a 5.4%
decrease in provincial income due to the oil price shock (Carbone & McKenzie, 2016).
Meanwhile, Wenar (2008) pointed out the property rights issues in exploitation of natural resources. The companies/institutions which gain the right to sell the resources can use the money in a way that produces/aggravates the “resource curse”, not in a way that increases the wealth of the people who should be beneficiaries of the resource wealth (Wenar, 2008).
Some studies suggest that political factors also may have a role in causing the resource curse. Gylfason (2001) found out that natural capitals in countries with low corruption
